House Financial Services Committee Roundtable On ESG Disclosures

I was fortunate to be invited to a roundtable on ESG organized by Congresswoman Maxine Waters on July 12, 2023. The transcript of my comments at the roundtable are reproduced below.

Transcript provided by the Shareholder Rights Group. The full video of the Roundtable is accessible here.

Maxine Waters (00:07:32):

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Starting this round table on environmental, social and governance or ESG investing. Before I begin again, I’d like to remind members in our panel that today’s round table is being live streamed and recorded. This month, Republicans have launched a full scale campaign against ESG. I convened today’s round table to help set the record straight on the false narratives being promoted by extreme MAGA Republicans, and to make clear why ESG disclosures are integral not only to financial performance, but the long-term global economy at large. ESG metrics, which include climate and human capital disclosures, are increasingly important to investors. The Republican culture war campaign, combating ESG and quote “wokeism,” comes at a time when climate change is becoming impossible to ignore. I will not mince words. Climate change poses a fundamental threat to America’s financial ecosystem, it’s businesses and to the global economy.

(00:08:44):

It is reckless to insist that climate change is not real and that corporations should not consider the real financial risk associated with climate change. Republican attacks on ESG are also a direct assault on diversity and inclusion efforts within our nation’s financial services industry, and if successful, will cause permanent damage to our nation’s economy. I’m very concerned that the United States Supreme Court’s decision to strike down affirmative action is emboldening extreme MAGA Republicans who are carrying out this anti ESG campaign, which we all know is really about pushing policies that are anti-women, anti-black, anti LGBTQ plus, and the list goes on. This anti ESG campaign is not just blind to the science behind climate change, it is also blind to the research clearly demonstrating how ESG factors are relevant to the long-term profitability of corporations, including research. Our committee identified showing that companies that are more diverse are more profitable.

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(00:09:59):

To help us discuss these issues in more depth, I’m very pleased to be joined by several experts. I will invite each of them to share, about three or four minutes of opening comments, and then we will open up to member questions. First, we will hear from Brooke, I think that is Lierman, who is the comptroller of the state of Maryland. Then we have Professor Shiva Rajgopal, who is a professor at the Columbia Business School. Then we will hear from Ben Cushing, who is campaign director at the Sierra Club. And finally, we will hear from Bhakti Mirchandani, who is the managing director of Responsible investing for Trinity Church Wall Street. Thank you for joining us, Ms. Lierman. I would go to you first for your opening remarks, and I would not feel insulted at all if you would pronounce your names before you get started, <laugh>.

Shivaram Rajgopal

Thank you. Thank you, Ms. Waters, it’s an honor to be here. I’m a professor of accounting and auditing at Columbia Business School. So, I’ll be brief so that we can have more time for Q&A. To me, ESG is an organic, investor driven movement that seeks greater accountability from corporate management. So, in that spirit, any bill that interferes with the freedom of choice in investing or singles out ESG for punitive treatment is a step backward. So are bills that make it difficult to table repeat proxy proposals or bills that mandate retail voting or pass through voting because you’ll eventually simply get retail voter apathy or voter capture. Bills that affect the independence or competition of the proxy advisory industry also need to be resisted because all this effectively gets in the way of seeking more accountability from corporate management.

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Turning to disclosure, one can think of ESG as a movement that simply asks for more data in response to a broken financial reporting model. The reporting model in my mind has simply not kept pace with the change of the nature of the economy. So as of now, we cannot operationalize ideas that we teach in a high school economics textbook for our trillion-dollar companies. How do you create value? It is by way of some combination of materials, labor, capacity, and managerial talent? If I look at a standard income statement, a six-line, opaque depiction of how the company makes money. So, think of ESG as simply an organic movement that evolved to ask questions about how the company makes money and the associated risks. Specific areas that need focus include climate risk, workforce disclosures, segment data, both operational segments and geographical segments and corporate taxes and grants and assistance that a company gets from the state. In closing, ESG can very much a pecuniary factor that affects future cash flows and risks of companies. I look forward to your questions.

Maxine Waters (00:40:46):

Now, I would like to open up the question and answer portion of our round table with a few questions, and then we will call on other members to be recognized for any questions they may have for Professor Rajgopal, as you know, the SEC’s proposed disclosure rule applies to only publicly listed companies. Would you comment on the benefits of extending these disclosure requirements to other similarly situated companies like privately held operating companies or companies that are owned by private equity funds? How would such disclosure inform and benefit the investors of those companies?

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Shivaram Rajgopal (00:41:33):

One of the problems with any kind of rule that is restricted to a sector is that it opens up the opportunity for arbitrage. So, what do I mean by that? Let’s say that public investors perceive more emissions as bad for the company’s prospects. The easiest thing for an oil and gas company, that has high reported emissions, is to simply divest a high emitting oil field and sell it to a private company or to the private equity portion of the market. A private company is generally exempt from reporting emissions and then it gets lost in ether space.

With respect to private equity, in general, there are good private equity firms and bad private equity firms. The bad ones rely on all kinds of interesting shenanigans such as sale leasebacks and dividend recaps or clever exploit bankruptcy law. None of that is obvious to any of us because they are “private.” But, I’m not even sure that they are strictly private because a lot of capital for private equity effectively comes from public pension funds. So, there is a case for the public to know more about the negative externalities imposed by private equity companies. Now, we do have the EPA, which does a little bit, which covers both private and public, but it’s probably not enough.

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Rep. Lynch (00:44:49):

Yeah, I do. I do. Just a quick one. In many cases we, we have a lack of transparency because of beneficial ownership. I’m just wondering, you, you’re tracking it for a different reason. You know, sometimes we’re, we’re looking at, you know, terrorist activity or you know, criminal activity, you’re looking, you’re looking at the same investment patterns for, and, and we run to you know, dead ends because many of these assets are, are bound up in these very difficult to ascertain trusts and there’s a whole industry out there to conceal the true ownership of assets. I was just wondering, are you, confronting the same difficulties in trying to determine whether these fund managers or, or others are, are actually you know, disclosing the true use of their investments?

Maxine Waters (00:45:59):

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To whom are you directing your question?

Rep. Lynch (00:46:01):

I, I guess professor Rajgopal

Shivaram Rajgopal (00:46:03):

Great, all the hard questions come to me! Let me give you an example so that, without naming names, there are hotel chains that are muscle light. I am sure you have heard of asset light companies, Facebook, and so on, and you must have heard of debt light companies, but I’d never come across muscle light companies. Consider a well know hotel chain that you and I must have stayed at. It takes hundreds and thousands of employees to run this chain. But if you look at where all this labor legally sits, it turns out that 20-30% of their large workforce is on their books, 20-30% of the workforce is managed by them but not legally employed by this hotel chain. The remaining 50-60% get lost in ether space. The audit trail of where these workers are tends to run cold as that they are hidden in some entity usually funded by a private equity firm.

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(00:46:56):

Rep. Brad Sherman (00:47:48):

The Republican position here is that this isn’t material. And it’s not material because it doesn’t immediately affect 5% one way or the other earnings per share. But today, their own witness testified that what is material is what investors want to know. Not not every investor. I only want to invest in companies where their offices are painted purple. I’m weird. We shouldn’t cater me to me, but there’s a huge group of investors who do care about the environment. And so the Republican attack on this is investors don’t care because, and it’s not material. And therefore we don’t, they’re not against this because investors don’t care. They’re against this because investors do care. This isn’t about cost. I mean, I’ve worked with Republicans on bills to, to, to send out less material on paper and more on electronically, and they save a lot of money and they save a lot of trees. And then how many investors can read it and can’t, you know, we can argue that one, we don’t have a series of three hearings about how to reduce costs of sending documents to investors. We have set of what? I think it, what, what do they have? They’ve scheduled 27 hearings this month on on this precisely because investors do care and they want to blind those investors. Now, their view is that every investor has to be Ebenezer, Scrooge. Ebenezer Scrooge does not care, at least in the first dream. And the second dream, maybe by the third dream he would, but in the, at least the initial, the, the original Ebenezer does not care whether the in his investments make the planet worse or better. Now, one thing that we fuzz up, because it kind of creates cognitive dissidence, is the difference between being the cause of an ESG problem and being hurt by an ESG problem.

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(00:50:10):

Causation and resiliency are kind of fuzzed together. The fact is they’re separate. Exxon might survive a 2% increase in Celsius degrees on the planet. The Maldives will not. They are different. And if you’re Ebenezer Scrooge, you would not invest in the Maldives. Not because they’re wrong, but because they’re shallow. They’re a couple feet above sea level. I would hope our Staff would take a look at the jurisdiction of our committee to make sure that we have jurisdiction over bills that say private companies have to report information to the SEC because we’re, we’re chartered to deal with, I wanna make sure it’s not commerce committee and how do we phrase it? So it’s not commerce committee. I guess I shouldn’t, nobody from the commerce committee should be listening. <laugh>.

(00:51:16):

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We certainly have jurisdiction over everything that’s in the public markets. One concern I have is it took the accounting profession a couple hundred years to give us what ends up being earnings per share in the balance sheet. We’ve gotta define, we’ve gotta design systems. We’ve gotta audit those systems. And I’m frankly concerned, and I realize, you know, everybody I know wants rate, scope one, scope two, scopes three, heck, I got, I know people who want Scope four <laugh>. But I, I wonder if we’re underestimating just how difficult that is. Cause I know how, you know, it’s easy to say, oh, well, got a balance sheet, you know, what goes on that and it’s 200 years. Do we, the, the people that would have the credibility to do this in the accounting world, would need to be professors of accounting theory or people who had risen to the level of partner in the technical review departments of major accounting firms. I haven’t met those people at any of the Sierra Club meetings I’ve attended and I’ve attended, well, 1% as much as Ben has <laugh>. But tell me, are there people with that kind of standing in the accounting theory world who are really working on this? Does anybody know?

Rep. Brad Sherman (00:52:48):

Professor,

Rep. Brad Sherman (00:52:51):

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They, they, if so it’d be you, but people, people you would hang out with.

Shivaram Rajgopal (00:52:55):

That’s not for me to say. That’s for you to say. But, let me add a couple of comments. So conceptually, this is no different from capturing value added right? In what sense? Why do we measure value added relatively well? Because we have a value added taxes. All you are asking for is nothing but carbon add in the value chain of a product or a service. So, the scope 1, 2, 3, business can be conceptually substituted away if you measure carbon value add.

Rep. Brad Sherman (00:53:39):

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With scope three what, what concerns me? And maybe I, I misunderstand. Okay. Your Bank of America, I know your Scope 1, I know where you get your utilities, I know your Scope 2. If you lend money to Zappos Pizza on Ventura Boulevard, you’re helping them do business. Do you then report differently versus whether that pizza outlet delivers the pizza in a carbon using vehicle, delivers the pizza in an electric vehicle, powered in a city that might use coal to generate the electricity that goes into the cars. Delivers by bicycle? Refuses to deliver, ut that means their patrons have to drive in and pick up the pizza, which is probably less efficient? Because there could be three people all coming from North Sherman Oaks to South Sherman Oaks in separate vehicles. Does Scope 3 mean that Bank of America has to look at how the pizzeria delivers its pizza?

Bhakti Merchandani (00:54:51):

Okay. so the draft SEC Climate Rules call for disclosure of Scope 3 only if they are material and if they’re related to a target, that’s,

Rep. Brad Sherman (00:54:59):

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Well, one pizzeria not material. Every small business Bank of America lends too? That’s material.

Bhakti Merchandani (00:55:09):

Yeah, I, I agree with that. There are challenges in measuring Scope 3 emissions, but with the requirements from the ISSB and from European regulators, the, the processes are improving as more people have to report Scope 3.

Rep. Sean Casten (01:03:44):

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Yeah, and part of why I ask the question, so I think if we treating this issue seriously, we would be having hearings on how we make sure there is consistent reporting in this industry. Professor Rajgopal, if, if we had that, and I don’t wanna be redundant on what Brad was saying, but great minds are thinking like it for at least medicore minds <laugh>. Does the audit community have the ability to opine the accuracy of that data?

Shivaram Rajgopal (01:04:10):

That’s a good question. Now, especially given litigation risk, if I were, I were a serious auditor, I’d be very hesitant. If you look at the so-called carbon auditors today, many of them are boutique firms, they have a small staff. My guess is that they don’t have the capital to survive one lawsuit. So, if you want this to be done seriously, then we need to have a conversation about litigation issues, especially given lack of consensus about definitions and measurement.

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(01:04:49):

I just want to add a quick footnote to the rating agency issue. We often conflate credit rating agencies with ESG rating agencies. Credit rating agencies have to address a very simple falsifiable question, is this company going to go bankrupt? What does that mean? We won’t pay interest, or we won’t pay principal. For ESG, what is that falsifiable question? Nobody knows. Without an investment context, ESG ratings can never be used effectively. So, I would suggest that ESG rating agencies are better viewed as data delivery services. Bhatki knows what she’s investing in, say DEI, because that’s her mission. The Comptroller knows what she is investing in. With the benefit of context, both Bhakti and the Comptroller can use ESG data from the rating agencies to inform their investment decision. The rating agency lacks that investment objective and the context and hence does odd things such as equally weighting E, S and G for instance.

Rep. Garcia (01:06:22):

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Well, I, no, I just, I think I just have two and, and, and one is, you know, I, I’m sitting here and listening to all, and first of all, in my district, we don’t really eat pizzas. We, we still depend on taco trucks. I

(01:06:36):

I have a 77% Latino district, so we’re not quite there yet. And as I listen to all this, I just want to ask, especially the professors, how do you break all this down to just explain to the average person without the, the talk from the SEC, without the professorial discussions on why this really matters? Because I have had that challenge in my town hall meetings. I’ve had that challenge in just trying to explain to people, you know, some of the things that I do on financial services, because they’re like, what does it really mean to me? So can y’all help me here with just the elevator speech as to why this stuff is important without using the word ESG SEC or any other ABC alphabet <laugh>?

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Shivaram Rajgopal (01:07:30):

I can try. So the average American worker is 42 years old.

Rep. Garcia (01:07:37):

42.

Shivaram Rajgopal (01:07:37):

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I think that’s what the, the Bureau of Labor Statistics reports. So, if you retire at the age of 65, what’s your horizon? 23 years at least, right? If you’re buying a target fund, which basically pays out in the year 2040 or 2050, by definition, you’re worried about 25 years in terms of your investment horizon. What will this company look like in 25 years? Will it even survive? A lot of the disputes about materiality and even the so-called pecuniary nature of ESG seem to cater to the “here and the now” momentum investor people who just get in and out of stocks versus somebody who holds this for 25 years. And when you look at a very long horizon, factors immaterial things for earnings per share this quarter become important, right? Climate is a slow moving but predictable problem.

How can data on workforce not be important? I mean, the average pizza guy that Congressman Sherman refers to knows his labor costs, I would imagine. But, we don’t know labor costs for 85% of corporate publicly listed America. And let’s turn to governance, how can that be anything more important than governance? The contract is that I give you capital and come back at the end of the year and ask you: “what have you done for me last year?”

Maxine Waters (01:16:59):

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Well said. I would like to take this moment to thank all of our panelists today. Your participation has been very informative. And for those of us who are really beginning to spend more time on ESG, we have a lot to learn. This is a huge idea, but you are talking about changing the world and you know, it’s exciting to think about all of the ways that everybody could be involved. And when we listen to Mr. Sherman talk about those bicycles that are going to be supported by the big banks, rather than having people drive in to get their pizzas, well, that puts us in his proper perspective. <laugh>, thank you so very much. Thank you all for being here.